Build Your Own Annuity

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Re: Build Your Own Annuity

Postby bobcat2 » Fri Mar 01, 2013 10:59 pm

I am mainly trying to make two points here.

The first is that life annuities and US bonds, including US savings bonds, are all relatively safe vehicles for retirement income. However, life annuities and bonds are not direct substitutes, but rather complements, because they have different strengths and weaknesses. Given that simple truth, the best strategy for most people in retirement is to have both types of safe retirement income. It isn't a case of either/or, but rather a case of how much of safe retirement income should come from life annuities and how much should come from US bonds such as savings bonds. In this sense it is different strokes for different folks, but few folks should have all their safe retirement income beyond SS tied up in just government bonds or life annuities. Instead they should have some of each. For individuals most worried about safe income for life, if either they or their spouse should live a particularly long life, more weight should be given to life annuities. For those more concerned about flexibility in the income stream, either while they are alive or after their death, and also relatively less concerned about the height of the safe income stream while alive, more weight should be given to safe income from government bonds.

The second point is that for retiree income to be truly safe, most of the 'safe' retirement income needs to be inflation protected. While you are working your wages will mainly keep up with inflation. But once you are retired and over 80, wage income is not an option. The elderly with only nominal income are taking on a lot of inflation risk. This risk could show up late in their lives when they are most vulnerable. Trying to forecast future inflation rates many years into the future is a fool's errand, and I know because I spent a good part of my working life developing and assessing long-term economic forecasts. One thing you learn in doing that is that it is impossible to make accurate forecasts of inflation several years from now. There are simply too many things that affect inflation to make prediction of LT inflation rates anything more than a bad guess. So better to have the inflation protection built in, than guess what the inflation rate may be and figuring your nominal assets will protect you from inflation, given that your inflation guess is reasonably accurate. Your inflation guess will not necessarily be reasonably accurate. :(

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Re: Build Your Own Annuity

Postby rr2 » Fri Mar 01, 2013 11:04 pm

bobcat2 wrote:I am mainly trying to make two points here.

The first is that life annuities and US bonds, including US savings bonds, are all relatively safe vehicles for retirement income. However, life annuities and bonds are not direct substitutes, but rather complements, because they have different strengths and weaknesses. Given that simple truth, the best strategy for most people in retirement is to have both types of safe retirement income. It isn't a case of either/or, but rather a case of how much of safe retirement income should come from life annuities and how much should come from US bonds such as savings bonds. In this sense it is different strokes for different folks, but few folks should have all their safe retirement income beyond SS tied up in just government bonds or life annuities. Instead they should have some of each. For individuals most worried about safe income for life, if either they or their spouse should live a particularly long life, more weight should be given to life annuities. For those more concerned about flexibility in the income stream, either while they are alive or after their death, and also relatively less concerned about the height of the safe income stream while alive, more weight should be given to safe income from government bonds.

The second point is that for retiree income to be truly safe, most of the 'safe' retirement income needs to be inflation protected. While you are working your wages will mainly keep up with inflation. But once you are retired and over 80, wage income is not an option. The elderly with only nominal income are taking on a lot of inflation risk. This risk could show up late in their lives when they are most vulnerable. Trying to forecast future inflation rates many years into the future is a fool's errand, and I know because I spent a good part of my working life developing and assessing long-term economic forecasts. One thing you learn in doing that is that it is impossible to make accurate forecasts of inflation several years from now. There are simply too many things that affect inflation to make prediction of LT inflation rates anything more than a bad guess. So better to have the inflation protection built in, than guess what the inflation rate may be and figuring your nominal assets will protect you from inflation, given that your inflation guess is reasonably accurate. Your inflation guess will not necessarily be reasonably accurate. :(

BobK

BobK -- you raise very good points esp. 2.
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Re: Build Your Own Annuity

Postby Mel Lindauer » Fri Mar 01, 2013 11:05 pm

bobcat2 wrote:I am mainly trying to make two points here.

The first is that life annuities and US bonds, including US savings bonds, are all relatively safe vehicles for retirement income. However, life annuities and bonds are not direct substitutes, but rather complements, because they have different strengths and weaknesses. Given that simple truth, the best strategy for most people in retirement is to have both types of safe retirement income. It isn't a case of either/or, but rather a case of how much of safe retirement income should come from life annuities and how much should come from US bonds such as savings bonds. In this sense it is different strokes for different folks, but few folks should have all their safe retirement income beyond SS tied up in just government bonds or life annuities. Instead they should have some of each. For individuals most worried about safe income for life, if either they or their spouse should live a particularly long life, more weight should be given to life annuities. For those more concerned about flexibility in the income stream, either while they are alive or after their death, and also relatively less concerned about the height of the safe income stream while alive, more weight should be given to safe income from government bonds.

The second point is that for retiree income to be truly safe, most of the 'safe' retirement income needs to be inflation protected. While you are working your wages will mainly keep up with inflation. But once you are retired and over 80, wage income is not an option. The elderly with only nominal income are taking on a lot of inflation risk. This risk could show up late in their lives when they are most vulnerable. Trying to forecast future inflation rates many years into the future is a fool's errand, and I know because I spent a good part of my working life developing and assessing long-term economic forecasts. One thing you learn in doing that is that it is impossible to make accurate forecasts of inflation several years from now. There are simply too many things that affect inflation to make prediction of LT inflation rates anything more than a bad guess. So better to have the inflation protection built in, than guess what the inflation rate may be and figuring your nominal assets will protect you from inflation, given that your inflation guess is reasonably accurate. Your inflation guess will not necessarily be reasonably accurate. :(

BobK


Again, I'll address the inflation concern by saying again that if inflation were to pick up, then simply replace purchasing EE Bonds with I Bonds for their inflation protection. And remember, too that unless you buy an expensive (and not readily available) inflation-adjusted SPIA, you have the same problem with the SPIA.
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Re: Build Your Own Annuity

Postby freebeer » Fri Mar 01, 2013 11:33 pm

bobcat2 wrote:...for retiree income to be truly safe, most of the 'safe' retirement income needs to be inflation protected... once you are retired and over 80, wage income is not an option. The elderly with only nominal income are taking on a lot of inflation risk.


Not really disagreeing but there's of course a question about how much one ought to worry about being "truly safe" out to an age when you're much more likely to be "truly dead". And studies show average spending tapers off later in retirement (admittedly nearer-end-of-life medical care can be an exception but you can get LTC insurance, there's always the Medicare backstop, as well as the "kids help" backstop (and a higher-equity/less-annuitized portfolio with that backstop may be a far better deal, on average, for them).
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Re: Build Your Own Annuity

Postby Epsilon Delta » Fri Mar 01, 2013 11:35 pm

Mel Lindauer wrote:
Epsilon Delta wrote:
Mel Lindauer wrote:a. For a 20-year period certain, the payout is 6.56% per year with the insurance company vs 10% per year payout for the 20-year EE Bond plan.

I think you're comparing apples and oranges here. The EE bonds are bought over a 20 year period, while the annuity is bought at the end of the period. You need to discount later payments, on average the annuity is bought over 10 years later.

The exact result will depend on how you choose to discount, but if you choose a 3.52% discount rate the payout rates are fairly close.


Obviously one of is isn't looking at this correctly. The money needed to purchase the SPIA didn't just fall out of the sky at the time of purchase. It would have been accumulated over the same period of time as the EE Bonds, so I fail to see any reason to discount it now. The EE Bonds were an investment over time as was the accumulation of the money needed to purchase the SPIA. Now at retirement, one can choose to redeem and spend the EE Bonds or use them as an annuity. Likewise, the accumulator can choose to spend the accumulated money or buy a SPIA. No discounting needed to make things equal.


I'll rephrase, looking forwards rather than backwards.

If you accumulate the premium for the SPIA over 20 years you get to invest it until you buy the annuity. So if you save $20,000 per year you have more than $400,000 per year to pay for the annuity. Earning about 3.52% during the accumulation phase gives you about $587,000 to buy a SPIA and 6.56% of that is $38,500, close to the $40,000 for the EE bonds.

Now perhaps you can't get 3.5%. You certainly don't want to use EE bonds for investments less than 20 years. But you could use I bonds, or treasuries, so something greater than 0% is in order unless you just stick the cash under a mattress.

Once you allow for investment growth during the accumulation of the SPIA premium you can see that the denominator for the 10% payout for the EE bonds is the the cost basis, but the denominator for the 6.6% SPIA is the value of the invested funds after years of growth. If you calculate the payout of the SPIA based on the lower cost basis you'll get a payout higher than 6.56%.
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Re: Build Your Own Annuity

Postby Mel Lindauer » Fri Mar 01, 2013 11:43 pm

Epsilon Delta wrote:
Mel Lindauer wrote:
Epsilon Delta wrote:
Mel Lindauer wrote:a. For a 20-year period certain, the payout is 6.56% per year with the insurance company vs 10% per year payout for the 20-year EE Bond plan.

I think you're comparing apples and oranges here. The EE bonds are bought over a 20 year period, while the annuity is bought at the end of the period. You need to discount later payments, on average the annuity is bought over 10 years later.

The exact result will depend on how you choose to discount, but if you choose a 3.52% discount rate the payout rates are fairly close.


Obviously one of is isn't looking at this correctly. The money needed to purchase the SPIA didn't just fall out of the sky at the time of purchase. It would have been accumulated over the same period of time as the EE Bonds, so I fail to see any reason to discount it now. The EE Bonds were an investment over time as was the accumulation of the money needed to purchase the SPIA. Now at retirement, one can choose to redeem and spend the EE Bonds or use them as an annuity. Likewise, the accumulator can choose to spend the accumulated money or buy a SPIA. No discounting needed to make things equal.


I'll rephrase, looking forwards rather than backwards.

If you accumulate the premium for the SPIA over 20 years you get to invest it until you buy the annuity. So if you save $20,000 per year you have more than $400,000 per year to pay for the annuity. Earning about 3.52% during the accumulation phase gives you about $587,000 to buy a SPIA and 6.56% of that is $38,500, close to the $40,000 for the EE bonds.

Now perhaps you can't get 3.5%. You certainly don't want to use EE bonds for investments less than 20 years. But you could use I bonds, or treasuries, so something greater than 0% is in order unless you just stick the cash under a mattress.

Once you allow for investment growth during the accumulation of the SPIA premium you can see that the denominator for the 10% payout for the EE bonds is the the cost basis, but the denominator for the 6.6% SPIA is the value of the invested funds after years of growth. If you calculate the payout of the SPIA based on the lower cost basis you'll get a payout higher than 6.56%.


Not sure what you're hypothetically using for your SPIA investment money during the accumulation phase, but it's obviously not as safe as the EE or I Bond route, and it's not guaranteed, so you're certainly not comparing apples to apples.

Remember, too, that while the EE Bonds double in value in 20 years, they still continue to earn the 0.2% compounded for an additional 10 years, so you end up with more than $40,000 (I haven't run the numbers to get the exact amount).
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Re: Build Your Own Annuity

Postby bobcat2 » Sat Mar 02, 2013 12:05 am

There's nothing wrong with buying an inflation-adjusted SPIA. It's not cheating, and they are readily available thru Vanguard for gosh sakes. Nor does the purchase have to be a one time event. You can buy them in chunks over time. In fact buying them in chunks over time is usually the best strategy.

What I find odd is the implicit insistence by some that you need to buy either bonds or life annuities. That the purchasing of some of both is some sort of not to be tolerated financial faux pas.

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Re: Build Your Own Annuity

Postby bobcat2 » Sat Mar 02, 2013 12:21 am

there's of course a question about how much one ought to worry about being "truly safe" out to an age when you're much more likely to be "truly dead". And studies show average spending tapers off later in retirement (admittedly nearer-end-of-life medical care can be an exception but you can get LTC insurance, there's always the Medicare backstop...
There is no Medicare backstop. There is a Medicaid backstop, but I am not perfectly comfortable assuming that backstop will be there decades from now. That certainly seems a lot more iffy than insurance companies becoming so bankrupt they can't make annuity payments.

Once you are 'truly dead' you have no financial worries. You are in Heaven and everything you could possibly desire is free. :D OTOH, if you remain alive a long time you do need to worry about income to support you and/or your spouse in those later years.

Many people, including some of my relatives under 60, are excluded from LTCi by underwriting. About half of the population at age 65 would be excluded from LTCi if they were to apply for it.

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Re: Build Your Own Annuity

Postby bertilak » Sat Mar 02, 2013 7:16 am

bobcat2 wrote:Many people, including some of my relatives under 60, are excluded from LTCi by underwriting. About half of the population at age 65 would be excluded from LTCi if they were to apply for it.

One thing "uninsurable" people can look for is some kind of group plan they might be eligible for.
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Re: Build Your Own Annuity

Postby irwinmfletcher » Sat Mar 02, 2013 7:44 am

Can someone explain why treasury is guaranteeing a 3.5% return after 20 years in this environment?

I had no idea this was the case--thanks Mel for posting.

Is it possible to buy these in an Ira and avoid (defer) the tax after the 20th year?
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Re: Build Your Own Annuity

Postby Mel Lindauer » Sat Mar 02, 2013 8:50 am

irwinmfletcher wrote:Can someone explain why treasury is guaranteeing a 3.5% return after 20 years in this environment?

I had no idea this was the case--thanks Mel for posting.

Is it possible to buy these in an Ira and avoid (defer) the tax after the 20th year?


First, EE Bonds are tax-deferred for up to 30 years, Irwin. Secondly, while there's no legal restriction against putting them in an IRA, there's a practical limitation. Your IRA must be held by a custodian, and AFAIK, there are no custodians who will purchase and hold Savings Bonds for your account. And, since they're already tax-deferred for up to 30 years, there's really no compelling reason to do so.
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Re: Build Your Own Annuity

Postby porro » Mon Mar 04, 2013 2:54 am

I remember reading about doing something similar by building a zero coupon bond ladder. Other than the possible need to do this kind of ladder in a tax-deferred account, because the interest accrues every year even though you don't receive the cash until later, wouldn't a zero coupon bond ladder work just as well? And you aren't restricted to buying only $10,000 a year in EE bonds. Fidelity offers zero coupons bonds and you don't have to deal with Treasury Direct, something that has given me problems in the past.
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Re: Build Your Own Annuity

Postby SGM » Mon Mar 04, 2013 5:47 am

I am following this arguement closely as I have had the arguement with myself in the past. Should we put some money into an annuity or would it be better to buy say Vanguard hi yield corporate bond fund and use it up over time in retirement. Several on this board advised against that particular fund but it has done well in the interim. But you could substitute I bonds, EE bonds, etc. and have a similar arguement.

I did put a chunk into a deferred savings annuity that works like an SPIA. Now it gets 3.96% yearly, but any new money going in will get only 1.85%. Therefore I stopped making additions. I can annuitize it immediately or later on. Five plus years from now I can access it all without penalty. I can access 10% per year starting last year without penalty. Maybe 1.85% deferred is not so bad as I could fully access it in 5 years. If I take it all out after its 7th year then it will have acted as a tax deferred CD and not an annuity. If I die the spouse gets it all as an insurance policy.

I will have to look into EE bonds. I would like to have other ways of increasing my tax deferred space other than IRAs, 401ks and the the above mentioned deferred savings annuity. I look at delaying my SS as a tax deferring strategy in addition to the increased payout at 70. I am increasing my non taxable space with Roth conversions too.

Has anyone had a quote recently from Vanguard for an inflation protected annuity? The rates started out so low that I thought laddered SPIAs looked better. Spouse has longevity in her genes big time and I am considering taking annuities in her name only, with a somewhat better yearly payout. Overcoming a predjudice against insurance companies is a hurdle for spouse whose Dad said, "Guess who paid for those huge modern buildings?"

I am all in on the delayed SS as being the best inflation adjusted annuity, at least for those close to retirement. I was impressed when my 24 yo said, "I heard SS may not be there when I need it." He is finally thinking a little about his future beyond next weekend, I hope.

I tend to hedge my bets and will put some money into SPIAs, inflation adjusted or laddered and feel lucky in terms of mortality credits, at least for one of us. All my other investments will be an income stream so could be looked at as an annuity in the broadest sense. I can live with the cognitive dissonance of agreeing with Mel and agreeing with BobK. :wink:
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Re: Build Your Own Annuity

Postby rick51 » Mon Mar 04, 2013 6:06 am

Not that such a product is currently available, but what percent of annual payout would you have to be offered to opt for a non-inflation protected SPIA vs inflation protection. Assume you have 30 years of life ahead of you.
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Re: Build Your Own Annuity

Postby bertilak » Mon Mar 04, 2013 7:34 am

rick51 wrote:Not that such a product is currently available, but what percent of annual payout would you have to be offered to opt for a non-inflation protected SPIA vs inflation protection. Assume you have 30 years of life ahead of you.

I plan on taking a different approach. I will buy an annuity that covers current expenses, w/o inflation protection. As inflation eats into that income I will incrementally buy additional non-inflation-indexed annuities. In this way
    I don't pay for the inflation protection.
    More of my money remains in investments that can grow (with dividends reinvested).
    I get more SPIA for my buck as I get older.
    I never have bought (paid for) more than I need.
    The annuities are diversified across time, as rates fluctuate.
    The annuities are diversified across insurance companies.
    There will be a bigger legacy to pass on.

I already have annuities that pay current expenses: a non-inflation-indexed pension and inflation-indexed SS so I will just need to carry out the second part of the plan -- incremental purchases to keep up with inflation. Actually, the plan is a little more subtle than that. I will still rely on investment returns to fund part of my retirement expenses. The annuities are to give me a guaranteed income stream large enough to satisfy the "sleep nights" criteria allowing a more aggressive growth and income strategy in my liquid investments.

My calculations show that I don't need to start in on the incremental annuities for three or four years at current inflation rates so this gives me time to assure myself that this is a workable plan. (I am two years into retirement.)
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Re: Build Your Own Annuity

Postby STC » Mon Mar 04, 2013 8:20 am

I completely agree with your theory Mel. Practical applications may vary based on the whole picture of the retirement portfolio. In my case I:

Every year:
- Max 401k (Wife & Me)
- Max Backdoor ROTH IRA (Wife & Me)
- Max IBonds (Wife & Me)

Years of excess:
- Max after-tax 401k, then convert to Roth
- Max EEBonds (Wife & Me)
- 529 to Gift limit
- Taxable

This year we are done with Roth & Ibonds. 401k is on pace for June. And saving more for a house down payment. We have $120k, but want to put down $200k in December. Then it just a simple matter of following the savings plan, the IPS, and enjoy live. Good to be 33 years old with an "old man" strategy. :)

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Re: Build Your Own Annuity

Postby bobcat2 » Mon Mar 04, 2013 9:31 am

bertilak wrote: I will buy an annuity that covers current expenses, w/o inflation protection. As inflation eats into that income I will incrementally buy additional non-inflation-indexed annuities. In this way
    I don't pay for the inflation protection.
    More of my money remains in investments that can grow (with dividends reinvested).
    I get more SPIA for my buck as I get older.
    I never have bought (paid for) more than I need.
    The annuities are diversified across time, as rates fluctuate.
    The annuities are diversified across insurance companies.
    There will be a bigger legacy to pass on.

I already have annuities that pay current expenses: a non-inflation-indexed pension and inflation-indexed SS so I will just need to carry out the second part of the plan -- incremental purchases to keep up with inflation. Actually, the plan is a little more subtle than that. I will still rely on investment returns to fund part of my retirement expenses. The annuities are to give me a guaranteed income stream large enough to satisfy the "sleep nights" criteria allowing a more aggressive growth and income strategy in my liquid investments.

Typically you cannot purchase life annuities beyond the age of 85. So if you are purchasing non-inflation indexed SPIAs and inflation accelerates after you turn 85, and if you or your spouse should live until your late 90s, then at that point you or your spouse will have your non-inflation indexed goose cooked for you - just at the time when you are most vulnerable and need the protection the most. Keep in mind that a big problem with buying nominal life annuities is that high inflation after age 85 will hit all of them with equal force, not just the ones purchased near age 85. :(

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Re: Build Your Own Annuity

Postby Austintatious » Mon Mar 04, 2013 10:20 am

THIS COMMENT HAS BEEN EDITED BY ITS AUTHOR, CORRECTING AN INACCURATE STATEMENT MADE REGARDING THE NATURE OF INSURANCE COMPANY FAILURES THAT HAVE RESULTED IN ANNUITY LOSSES. PRIOR TO THE CORRECTION, THIS COMMENT WOULD HAVE LED THE READER TO CONCLUDE THAT THE LOSSES MAY HAVE BEEN GREATER THAN HAD ACTUALLY OCCURRED. THE CORRECTED PORTION IS IN ITALICS. THE AUTHOR OFFERS HIS APOLOGY FOR THE INACCURACY.

One of the better threads I've followed, here, IMO, well demonstrating the pros and cons of each alternative. To me, it simply could not be more clear that the savings bond alternative is the safest option for assuring that vital income streams will be there later in life. Insurance companies can and do fail. Though quite rare, it seems there have been at least two instances where annuitants have suffered partial losses of their annuity benefits as the result of insurance company failures, both having occurred before the 2008 financial crisis.[/i] The clincher for me, on the safety issue, is the recent and very clear proof that the various regulatory agencies may not be safely relied on to assure that the even the highest rated inscos and the other big financial houses refrain from the kinds of practices that brought this nation to the brink of comprehensive financial collapse just a few years ago. Going the savings bond route may be more difficult to orchestrate, may require more thoughtful planning and may provide a smaller bang for one's buck, but it's the one most likely to be there in the event of financial calamity, be it the failure of a single insco or financial collapse on a national scale.
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Re: Build Your Own Annuity

Postby bertilak » Mon Mar 04, 2013 10:25 am

bobcat2 wrote:Typically you cannot purchase life annuities beyond the age of 85. So if you are purchasing non-inflation indexed SPIAs and inflation accelerates after you turn 85, and if you or your spouse should live until your late 90s, then at that point you or your spouse will have your non-inflation indexed goose cooked for you - just at the time when you are most vulnerable and need the protection the most. Keep in mind that a big problem with buying nominal life annuities is that high inflation after age 85 will hit all of them with equal force, not just the ones purchased near age 85. :(

Good point. That's some fine tuning I should put into the small print somewhere! Anyway, that's almost 20 years away. My plan will surely have been revisited before then. Who knows, there may be something better available in 10-15 years. Maybe there already is and I just haven't found it yet.

I am quite open to new ideas here. Annuities are ALREADY a new idea to me. Up to now I have always been frustrated by trying to balance my AA between safety and growth, growth covering inflation, a splurge now and then, and a potential legacy. Too conservative and I might get eaten alive by inflation; too aggressive and I might fall overboard. My above plan *seems* to cover all angles.

EDITS:

PS: re "if you or your spouse should live until your late 90s ... non-inflation indexed goose cooked..." My spreadsheet for this plan shows that the balance of my liquid investments will remain high. My cost basis for the annuities will peak at about one third of total investments, even with a "black swan" loss of 20% factored in at the worst time (now). Various assumptions about the size of the black swan and the inflation rate mostly keep me on an even keel. Of course one can ALWAYS make assumptions that result in failure.

PPS: Perhps I should look at inflation-indexed annuities. I just remember Wade Pfau's study where inflation-indexed annuities did worse than nominal annuities at avoiding "failures", meaning the overall portfolio not supplying the needed cash flow.
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Re: Build Your Own Annuity

Postby bertilak » Mon Mar 04, 2013 10:28 am

Austintatious wrote:One of the better threads I've followed, here, IMO, well demonstrating the pros and cons of each alternative. To me, it simply could not be more clear that the savings bond alternative is the safest option for assuring that vital income streams will be there later in life. Insurance companies can and do fail. Though quite rare, it seems there have even been instances where annuitants have came up short, left only with the minimum coverage provided by the association insuring against failures in their state. The clincher for me, on the safety issue, is the recent and very clear proof that the various regulatory agencies may not be safely relied on to assure that the even the highest rated inscos and the other big financial houses refrain from the kinds of practices that brought this nation to the brink of comprehensive financial collapse just a few years ago. Going the savings bond route may be more difficult to orchestrate, may require more thoughtful planning and may provide a smaller bang for one's buck, but it's the one most likely to be there in the event of financial calamity, be it the failure of a single insco or financial collapse on a national scale.

I think I agree with you for those investors still in the accumulation phase with maybe 20 years to go before retirement. In my case I am already retired and buying bonds to hold to maturity simply does not get me enough.
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Re: Build Your Own Annuity

Postby SnapShots » Mon Mar 04, 2013 11:08 am

KarlJ wrote:I found the article very thought-provoking. The example of the 60 year old starting to buy EE bonds to cover spending needs in 20 years is especially interesting to me as it may be a strategy I could apply.


ditto...
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Re: Build Your Own Annuity

Postby Austintatious » Mon Mar 04, 2013 11:17 am

bertilak wrote:

I think I agree with you for those investors still in the accumulation phase with maybe 20 years to go before retirement. In my case I am already retired and buying bonds to hold to maturity simply does not get me enough.


And I think I agree with you. The greatest potential seems to be for those young enough to build a sizable "corpus", and smart enough to start building it early. I missed both of those boats and I'm retired, as well. I mentioned earlier in this thread that I really like the idea of an annuity, a reliable income stream kicking in, later in life. That's why I've been thinking a lot recently about another annuity (besides pension and SS) as a future supplemental benefit for my now 60 y.o. wife, as part of our overall plan. I've never been comfortable relying on insurance companies and, now, because I have near zero trust in the regulators to protect consumers of insurance products, and also because the purchasing power of today's dollar is so poor in today's annuity market, I've been looking for alternatives. So, I'm thinking more about something like the Lindauer EE bond/I bond model discussed here. Nothing big, maybe $500 to a $1,000 a month, just a little cushion or some fun money or, if we're lucky, a little something extra left over for the kids. Though it may not be a practical solution for everyone, it sure seems to me that this approach offers the greatest assurance that it'll be there, and that's something to consider.
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Re: Build Your Own Annuity

Postby Leesbro63 » Mon Mar 04, 2013 11:26 am

I have a 65 year old friend who decided to buy a portfolio of blue chip individual stocks with 5% dividends instead of annuitizing. His thinking was that he wouldn't get much more than 5% from the annuity, and that the risk of the dividends being significantly cut/companies going broke are less than the risk of dying before breaking even on the annuity. And if things go well, the dividends will PROBABLY at least keep up with inflation. And his heirs will get something.

Something to think about, especially for people without exceptional family longevity history.
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Re: Build Your Own Annuity

Postby Mel Lindauer » Mon Mar 04, 2013 11:35 am

Austintatious wrote:
bertilak wrote:

I think I agree with you for those investors still in the accumulation phase with maybe 20 years to go before retirement. In my case I am already retired and buying bonds to hold to maturity simply does not get me enough.


And I think I agree with you. The greatest potential seems to be for those young enough to build a sizable "corpus", and smart enough to start building it early. I missed both of those boats and I'm retired, as well. I mentioned earlier in this thread that I really like the idea of an annuity, a reliable income stream kicking in, later in life. That's why I've been thinking a lot recently about another annuity (besides pension and SS) as a future supplemental benefit for my now 60 y.o. wife, as part of our overall plan. I've never been comfortable relying on insurance companies and, now, because I have near zero trust in the regulators to protect consumers of insurance products, and also because the purchasing power of today's dollar is so poor in today's annuity market, I've been looking for alternatives. So, I'm thinking more about something like the Lindauer EE bond/I bond model discussed here. Nothing big, maybe $500 to a $1,000 a month, just a little cushion or some fun money or, if we're lucky, a little something extra left over for the kids. Though it may not be a practical solution for everyone, it sure seems to me that this approach offers the greatest assurance that it'll be there, and that's something to consider.


I'm glad you mentioned buying EE Bonds in smaller amounts. The plan will work just as well with $100, $500, $1000 or any amount you can afford to invest in the EE Bond ladder for 20 years. Whatever amount you invest will provide you with twice that amount as an income stream in 20 years. The main reason I used the $10,000 and $20,000 figures in the column was because of the annual EE Bond purchase limits.
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Re: Build Your Own Annuity

Postby alec » Mon Mar 04, 2013 1:52 pm

Austintatious wrote:One of the better threads I've followed, here, IMO, well demonstrating the pros and cons of each alternative. To me, it simply could not be more clear that the savings bond alternative is the safest option for assuring that vital income streams will be there later in life. Insurance companies can and do fail. Though quite rare, it seems there have even been instances where annuitants have came up short, left only with the minimum coverage provided by the association insuring against failures in their state. The clincher for me, on the safety issue, is the recent and very clear proof that the various regulatory agencies may not be safely relied on to assure that the even the highest rated inscos and the other big financial houses refrain from the kinds of practices that brought this nation to the brink of comprehensive financial collapse just a few years ago. Going the savings bond route may be more difficult to orchestrate, may require more thoughtful planning and may provide a smaller bang for one's buck, but it's the one most likely to be there in the event of financial calamity, be it the failure of a single insco or financial collapse on a national scale.


Austintatious,

Do you have any examples [of the part I bolded] where annuitants receiving monthly payments were "left only with the minimum coverage provided by the association insuring against failures in their state"? The only one I know of is Executive Life, where the annuitants received 70% of their monthly annuities for more than a year until another insurance company took over the payments and the payments went back to 100%.
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Re: Build Your Own Annuity

Postby Austintatious » Mon Mar 04, 2013 2:40 pm

alec wrote:

Austintatious,

Do you have any examples [of the part I bolded] where annuitants receiving monthly payments were "left only with the minimum coverage provided by the association insuring against failures in their state"? The only one I know of is Executive Life, where the annuitants received 70% of their monthly annuities for more than a year until another insurance company took over the payments and the payments went back to 100%.


My initial impression is that it's rare. I only started looking closer at the subject of insco failures and how they might affect annuitants after getting into this thread. I came across this Aug, 2012 article - How Safe Are Annuities? - on the http://www.advisorperspectives.com website. It references the 1983 banckruptcy of a company named Baldwin-United that, after a takeover by Met life, resulted in court-ordered reductions in benefits. It also mentions that 1991 failure of Executive Life that you mention just above, but it says that that purchasers of its annuities would be suffering losses if the annuities exceeded the guaranty caps. It did NOT state, as I inaccurately stated in my comment, that the annuitants would be left only with the minimum. Thanks for drawing my attention to theinaccuracy of my statement, which I intend to correct. The article also mentions that there were 70 insco failures between 1991 and 2011, most of them between 1991and 1994 and are attributed to the companies embracing junk bonds. It also mentions that there was an uptick of failures, following the 2008 financial crisis, and goes on to say that this spike in failures was "... hardly alarming given the stresses on the financial system".
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Build Your Own Inflation Adjusted Annuity

Postby Clive » Mon Mar 04, 2013 3:22 pm

To build an inflation uplifted annuity, lets assume the total investment amount is $1M

Downloading the TIP ladder calculator from http://www.flexibleretirementplanner.co ... nal-tools/ and loading recent TIPS yield curve data indicates that for a 30 year ladder of TIPS loading $700,000 would secure a $23,000 yearly inflation adjusted income (2.3% real).

Loading the remainder $300,000 into a growth portfolio that had a 30 year annualised real reward expectancy of 4% would see that $300,000 grow to $1,000,000 in real terms (inflation adjusted) over 30 years.

I've used some broad rounding in the above figures to keep things simple

If after 30 years when the TIPS ladder was exhausted the $300K growth pot had just paced inflation, there's still some fund available to support additional years of drawdown. If the growth pot achieved its 4% real target then the total value at that time is the same in inflation adjusted terms as at the the start date. If the growth pot grew more than 4% real then there would be opportunity to profit take to top up income.

2.3% real when starting from a period when TIPS yields were broadly negative, is still a reasonable figure. Add on a couple of percent inflation and that's 4.3% nominal. Should inflation rage then you have inflation protection. And you or your heirs get to retain control of the funds. No counter-party risks involved for the income side of things as that's fully backed by the treasury, who can increase taxes or print more money rather than default.

That's somewhat like cost averaging into shares over time. Initially you've allocated 30% to growth (70% to income/drawdown), but over the years the growth pot proportionately increases in weighting as it grows and the the income pot declines. If that growth pot is something like Wellesley Balanced (VWINX) then after having loaded the TIPS ladder and bought VWINX there's no further mental capacity required (should dementia set in, or your husband/wife is widowed and takes over responsibility for the investments).

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Re: Build Your Own Annuity

Postby Mel Lindauer » Mon Mar 04, 2013 3:25 pm

Austintatious wrote:
alec wrote:

Austintatious,

Do you have any examples [of the part I bolded] where annuitants receiving monthly payments were "left only with the minimum coverage provided by the association insuring against failures in their state"? The only one I know of is Executive Life, where the annuitants received 70% of their monthly annuities for more than a year until another insurance company took over the payments and the payments went back to 100%.


My initial impression is that it's rare. I only started looking closer at the subject of insco failures and how they might affect annuitants after getting into this thread. I came across this Aug, 2012 article - How Safe Are Annuities? - on the http://www.advisorperspectives.com website. It references the 1983 banckruptcy of a company named Baldwin-United that, after a takeover by Met life, resulted in court-ordered reductions in benefits. It also mentions that 1991 failure of Executive Life that you mention just above, but it says that that purchasers of its annuities would be suffering losses if the annuities exceeded the guaranty caps. It did NOT state, as I inaccurately stated in my comment, that the annuitants would be left only with the minimum. Thanks for drawing my attention to theinaccuracy of my statement, which I intend to correct. The article also mentions that there were 70 insco failures between 1991 and 2011, most of them between 1991and 1994 and are attributed to the companies embracing junk bonds. It also mentions that there was an uptick of failures, following the 2008 financial crisis, and goes on to say that this spike in failures was "... hardly alarming given the stresses on the financial system".


One possible problem not mentioned is that there could be delays in getting the failed insurance company's promised annuity payments in a timely fashion until the whole mess gets straightend out. That could possibly cause a severe hardship on folks who depend on timely payments to pay their rent or buy their food and meds. While they may eventually be made whole (or nearly whole), that doesn't undo the damage that might be done while they were waiting for the resolution of the insurance company's failure.
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Re: Build Your Own Inflation Adjusted Annuity

Postby Clive » Mon Mar 04, 2013 4:06 pm

Clive wrote:Downloading the TIP ladder calculator from http://www.flexibleretirementplanner.co ... nal-tools/

A neat feature of that Excel spreadsheet is that you can change the values in column C to vary over time as you deem fit. For instance if after 7 years a private pension starts, and another 5 years later state pension starts, then you might adjust (reduce) the income required from those years to reflect those alternative sources of income.
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Re: Build Your Own Annuity

Postby umfundi » Tue Mar 05, 2013 2:56 am

On some of the points above.

I went into the safety of insurance companies when GM offered to buy out my pension last year. I would classify companies like Prudential as too big to fail. The insurance industry has a huge stake in its own reputation. I do not worry at all that Prudential now has my pension which has an NPV of over $1 million. I worried much more that GM might turn it over to the PBGC. Look at what happened to Delphi salaried retirees.

Annuity guarantees are covered by state law, but they are guaranteed by the industry, not by the state. It depends on where you currently live, not where you lived when you bought the annuity.

My annuity strategy includes delaying Social Security to effectively purchase a no-risk inflation indexed annuity with survivor benefits. That will goose my income with a goose that this unlikely to be cooked. I would be interested in Mel's opinion on doing this rather than taking SS at 62 and purchasing that $20,000 EE Bond ladder.

I am with Bertilak on buying nominal SPIAs when I need them. From what I recall, a nominal annuity with survivor benefits will pay 6%, an inflation protected annuity just less that 4%. That seems like a high premium, especially since the inflation outlook is low, declining to 1% in 10 years. (That's what Vanguard and the Fed say.)

Buying explicit inflation protection is expensive, and entails giving up potential equity returns. I do not think it is a good long-term proposition. 0-7 years? Yes. Beyond that, invest in the market of goods and services, and purchase secured shorter term income as you need it. At least, that's my plan.

And, by the way, observe what Taylor Larimore has done. He and his wife Pat purchased annuities, and are now proceeding to gift while they are alive. They have separated their lifetime income needs from their legacy.

Best wishes,

Keith
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Re: Build Your Own Annuity

Postby Aptenodytes » Tue Mar 05, 2013 7:11 am

I'm a little late to the party here -- just read Mel's column and (as often happens here) learned a lot.

By coincidence I had been just recently thinking about diverting a greater fraction of my money to my TIAA traditional annuity which offers a floor of 3% [edited to correct the floor -- the floor is 3% but the actual payments have been more like 4% for my vintage]. It seems that people who have access to this instrument, at this floor, the EE ladder doesn't offer anything substantially better. The main difference is that the EE doubling promise is backed by the US Government and TIAA's promise of a 3% floor is backed by a private firm.

Apologies if this came up already -- I read the second page of posts but didn't scan the first.
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Re: Build Your Own Annuity

Postby bobcat2 » Tue Mar 05, 2013 7:13 am

umfundi writes.
I am with Bertilak on buying nominal SPIAs when I need them.
What will you do if you need them beyond age 85, because beyond age 85 you cannot buy them? Your strategy would be OK if you could buy them as needed beyond age 85. Unfortunately for both you and your strategy you cannot do that. :oops:

In advanced old age there are two primary financial risks - longevity risk and inflation risk. Right at the time when you and/or your spouse need inflation protection the most, when you are very old and frail, you will not have it. There is little point in saying I will buy "nominal SPIAs when I need them", when the fact is when you will most need them you will be prohibited from buying them. :(

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Re: Build Your Own Annuity

Postby Levett » Tue Mar 05, 2013 7:30 am

Aptenodytes--

Do not take this query in the wrong way, but can you provide a citation from TIAA that provides you with a 4% guarantee.

I have never seen a TIAA Traditional program that exceeds a 3% guarantee.

For the record, I have just about 45 years experience working with TIAA, including the Traditional Account.

Thanks much.

Lev

P.S. I'm guessing, but this may be where you saw the 4%--

THE GRADED PAYMENT METHOD – initial income is based on a 4% interest rate (21⁄2% guaranteed plus 11⁄2% from additional amounts). If the total payout interest rate exceeds 4%, any remaining additional amounts, over and above the amount needed to bring initial income to a level based on a 4% interest rate, are rein- vested and used to buy you additional future income. The result is that your payments are likely to increase throughout your retirement to help protect you against inflation. You receive the initial amount from your retirement start date through December of that year. Your income changes are effective on January 1. As long as the guaranteed interest plus the additional amount exceed 4%, your income will increase the following year. If the guaranteed interest plus the additional amounts is less than 4%, your income could decrease.

If so, read very carefully as it only applies to "initial income"--e.g., first year. If 4% threshold is not achieved in subsequent years, as the paragraph explicitly states, "your income could decrease."
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Re: Build Your Own Annuity

Postby Aptenodytes » Tue Mar 05, 2013 7:31 am

Levett wrote:Aptenodytes--

Do not take this query in the wrong way, but can you provide a citation from TIAA that provides you with a 4% guarantee.

I have never seen a TIAA Traditional program that exceeds a 3% guarantee.

For the record, I have just about 45 years experience working with TIAA, including the Traditional Account.

Thanks much.

Lev

I already edited the error -- realized the mistake right after I posted. Thanks for the catch and gentle reprimand.
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Re: Build Your Own Annuity

Postby Levett » Tue Mar 05, 2013 7:36 am

No reprimand intended. And thank you for your courteous reply.

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Re: Build Your Own Annuity

Postby Levett » Tue Mar 05, 2013 7:40 am

"Your strategy would be OK if you could buy them as needed beyond age 85."

Bob, Immediateannuity does sell SPIAs at age 90. Heckuva payout! :)

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Re: Build Your Own Annuity

Postby bertilak » Tue Mar 05, 2013 8:34 am

bobcat2 wrote:umfundi writes.
I am with Bertilak on buying nominal SPIAs when I need them.
What will you do if you need them beyond age 85, because beyond age 85 you cannot buy them? Your strategy would be OK if you could buy them as needed beyond age 85. Unfortunately for both you and your strategy you cannot do that. :oops:

In advanced old age there are two primary financial risks - longevity risk and inflation risk. Right at the time when you and/or your spouse need inflation protection the most, when you are very old and frail, you will not have it. There is little point in saying I will buy "nominal SPIAs when I need them", when the fact is when you will most need them you will be prohibited from buying them. :(

BobK


You mentioned this earlier and I agree that it needs to be taken into account (although I don't go so far as to call it a problem). Since the retiree (or at least I) will not have annuitized everything there is still a substantial amount remaining as liquid investments at age 85. I believe that will provide enough SWR to cover inflation from age 85 on. If I had bought inflation-indexed annuities I would have much less remaining in the liquid part of my portfolio. A quick fiddle with my spreadsheet shows that at age 100 I still have "more than enough" income but less of that income is guaranteed. The non-guaranteed part stays below 25% of my needed income, below the expected total return AND below even the dividend yield. (This is even assuming a 30% loss in the first year.)

My situation is that much of my retirement income is from my non-indexed pension so even if I buy ALL inflation-indexed annuities I STILL don't have 100% inflation protection and never will no matter what I do. So what you say is true but perhaps not too significant.
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Re: Build Your Own Annuity

Postby gw » Tue Mar 05, 2013 9:11 am

As an annuity replacement ("build your own") this is a really terrible plan.

The reason is obviously mortality credits (as BobK has been saying), but neither the article nor this thread make it clear. The point is not that the annuity outlives the 30-year bond ladder (although it does), nor that only it can provide inflation protection (it can) --- the point is simply that the annuity provides way more income.

Here's the apples-to-apples comparison, which really should have been in the article, or at least in the first reply to this thread....

Compare the income at age 65 from either the bond ladder or the annuity. Assume a constant 3.5% return on the bonds (equivalent to doubling in 20 years), invested from 30 years prior to age 65. Assume an SPIA pays out at 6.5% (borrowed this number from the thread, sounds about right). The rest is easy. The bond ladder is worth about $1M at age 65 (excel FV(.035,30,20)), and pays out $40K per year for 30 years. Buying a $1M SPIA pays out $65K per year for the remainder of your life.

Obviously someone could choose the bond ladder over the annuity for valid reasons. However, if the goal is to have the benefits of an annuity (maximum safe income for the rest of your life, full stop), then a bond ladder is a terrible alternative, because (a) it risks running out of money and (b) it risks not running out of money, i.e., not being able to spend as much as you could with an SPIA.

So I found the title of the article, and the article itself, very misleading.

[edit: Apparently a 65-year-old male can get $71K today (http://www.brkdirect.com/spia/EZQUOTE.ASP), somewhat better than what I assumed above.]
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Re: Build Your Own Annuity

Postby umfundi » Tue Mar 05, 2013 9:13 am

bobcat2 wrote:umfundi writes.
I am with Bertilak on buying nominal SPIAs when I need them.
What will you do if you need them beyond age 85, because beyond age 85 you cannot buy them? Your strategy would be OK if you could buy them as needed beyond age 85. Unfortunately for both you and your strategy you cannot do that. :oops:

In advanced old age there are two primary financial risks - longevity risk and inflation risk. Right at the time when you and/or your spouse need inflation protection the most, when you are very old and frail, you will not have it. There is little point in saying I will buy "nominal SPIAs when I need them", when the fact is when you will most need them you will be prohibited from buying them. :(

BobK

Bob,

I am 62, and 85 is 23 years away, if I get there. By delaying SS I am purchasing a measure of inflation protection. I think it is entirely premature for me to worry much about inflation a quarter century hence when my current income needs are adequately funded plus we have a large portfolio invested at 50/50.

As my DB pension is eroded by inflation I intend to purchase SPIAs to compensate. Buying indexed SPIAs is not the only way to address the inflation issue.

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Re: Build Your Own Annuity

Postby bobcat2 » Tue Mar 05, 2013 9:41 am

gw writes.
As an annuity replacement ("build your own") this is a really terrible plan.

The reason is obviously mortality credits (as BobK has been saying), but neither the article nor this thread make it clear. The [main] point is not that the annuity outlives the 30-year bond ladder (although it does), nor that only it can provide inflation protection (it can) --- the [main] point is simply that the annuity provides way more income.
:thumbsup :thumbsup

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Re: Build Your Own Annuity

Postby bobcat2 » Tue Mar 05, 2013 11:37 am

Hi Umfundi,

We certainly look at this differently. Apparently both our households are delaying SS benefits, but also get a significant amount of our retirement income from nominal DB pensions. In our household we look at this and conclude - given the large amount of nominal annuitized income we already have from DB pensions that will be eroded by inflation, we don't need additional relatively risky nominal annuitized income. You appear to turn this sentiment on its head. Given we have safe real annuitized income from SS, we need only additional relatively risky nominal annuitized income. :D

You do realize that when you buy additional SPIAs over time to compensate for the declining real value of the DB pension income, that the relative cost of real annuities vs nominal annuities will depend on the inflation rate over time. If the inflation rate turns out to be low, the nominal SPIAs will have been less costly. :D That will not be the case if the inflation rate turns out to be high. :(

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Re: Build Your Own Annuity

Postby crowd79 » Tue Mar 05, 2013 12:05 pm

Ever Ready wrote:Thanks to Mel for a great article (as usual).

One point that is often overlooked is that the guaranteed rate on EE savings bonds can be changed for both newly issued and existing bonds.
This has happened in the past in response to changing interest rate environments. It may seem unlikely to many that rates could go lower, but for something
that one is counting on to provide retirement income, in this case, a guarantee is not a guarantee.


All we can go by is what we know right now. If treasury does adjust the terms of EE's, then I'll have to re-evaluate my monthly $250 EE laddering strategy. As it stands now, 3.53% is hard to beat as a guarantee over 20 years when compared to treasuries, current CD rates, and perhaps even I Bonds, if CPI-U and interest rates remain below 3.5% on average over the course of 20 years. If EE's don't beat annuities, well then at least I can pass them onto my heirs when I die and there's no risk of the insurance company going belly up or cutting benefits.
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Re: Build Your Own Annuity

Postby umfundi » Tue Mar 05, 2013 12:22 pm

bobcat2 wrote:Hi Umfundi,

We certainly look at this differently. Apparently both our households are delaying SS benefits, but also get a significant amount of our retirement income from nominal DB pensions. In our household we look at this and conclude - given the large amount of nominal annuitized income we already have from DB pensions that will be eroded by inflation, we don't need additional relatively risky nominal annuitized income. You appear to turn this sentiment on its head. Given we have safe real annuitized income from SS, we need only additional relatively risky nominal annuitized income. :D

You do realize that when you buy additional SPIAs over time to compensate for the declining real value of the DB pension income, that the relative cost of real annuities vs nominal annuities will depend on the inflation rate over time. If the inflation rate turns out to be low the nominal SPIAs will be less costly. :D That will not be the case if the inflation rate turns out to be high. :(

BobK

Bob,

At the moment (age 62) if I were to take SS we would have sufficient for our basic needs ('floor") from SS and my DB pension. We also have a comfortable 7-figure nest egg, in the form of IRA savings.

But, I appreciate that my DB pension will be eroded by inflation. I intend to compensate somewhat for that over the next 8 years by spending forward our savings to delay SS. By the time I reach 70, my SS payment will be 80% higher than at age 62. That increase is equal to 32% of my pension, substantially more than I expect inflation will be over that period. (I can't believe how good this deal is, particularly since my wife has her own SS entitlement.)

In other words, I expect to be in my mid to late 70s before the issue of further compensating my DB pension for inflation comes up.

I do not think the question is about risk in nominal vs. indexed SPIAs. It is how best to handle long-term inflation risk. Both the Fed and Vanguard have the 10-year inflation outlook at 2% and declining. The premium for an indexed SPIA vs. a nominal one does not look to me like a very good deal right now.

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Re: Build Your Own Annuity

Postby rr2 » Tue Mar 05, 2013 3:27 pm

gw wrote: The bond ladder is worth about $1M at age 65 (excel FV(.035,30,20)), and pays out $40K per year for 30 years. Buying a $1M SPIA pays out $65K per year for the remainder of your life.

I was trying to do the reverse. At age 65, what is the present value of the stream of payments = $40K for the next 30 years. I get PV(0.035,30,-40000) = $735682. What am I missing here?

The only caveat is that the EE bond rate of 3.5% is only if the bonds are held for 20 years. Also, what is the rate beyond year 20? Will it just be paid at the prevailing rates at that time?
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Re: Build Your Own Annuity

Postby Angst » Tue Mar 05, 2013 3:37 pm

rr2 wrote:The only caveat is that the EE bond rate of 3.5% is only if the bonds are held for 20 years. Also, what is the rate beyond year 20? Will it just be paid at the prevailing rates at that time?

Beyond year 20, it will just continue paying the fixed rate set when the bond was purchased. If bought today (up thru April 2013), that would be 0.2%
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Re: Build Your Own Annuity

Postby rr2 » Tue Mar 05, 2013 3:40 pm

Aptenodytes wrote:I'm a little late to the party here -- just read Mel's column and (as often happens here) learned a lot.

By coincidence I had been just recently thinking about diverting a greater fraction of my money to my TIAA traditional annuity which offers a floor of 3% [edited to correct the floor -- the floor is 3% but the actual payments have been more like 4% for my vintage]. It seems that people who have access to this instrument, at this floor, the EE ladder doesn't offer anything substantially better. The main difference is that the EE doubling promise is backed by the US Government and TIAA's promise of a 3% floor is backed by a private firm.

Apologies if this came up already -- I read the second page of posts but didn't scan the first.

I have TIAA CREF as well. Approximately 30% of our holdings are in TIAA Traditional with the 3% guarantee. I hold no other bonds. Slowly, we will be increasing the TIAA Traditional fraction so that it is about 45-50% at age 65. The plan is to annuitize this with the graded option. This along with SS should cover most of our retirement expenses assuming a paid off house.
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Re: Build Your Own Annuity

Postby letsgobobby » Tue Mar 05, 2013 3:58 pm

mephistophles wrote:The SPIA or self-constructed versions of it spend your original principal down to zero (excluding any refund features). That said, I have long been of the opinion that maintaining principal and living off its investment income is, by far, the preferred choice, if one can do so.
ole meph

likewise, i have also been of the opinion that being rich is better than being not rich. :D
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Re: Build Your Own Annuity

Postby Mel Lindauer » Tue Mar 05, 2013 11:25 pm

gw wrote:As an annuity replacement ("build your own") this is a really terrible plan.


Sounds like something I’d expect to hear from an insurance company, but not a Boglehead.

gw wrote:'The reason is obviously mortality credits (as BobK has been saying), but neither the article nor this thread make it clear. The point is not that the annuity outlives the 30-year bond ladder (although it does), nor that only it can provide inflation protection (it can) --- the point is simply that the annuity provides way more income.


In my column, I clearly stated that if the annuitant lived beyond 95 or 100, the SPIA might be the better choice.

gw wrote:Here's the apples-to-apples comparison, which really should have been in the article, or at least in the first reply to this thread....


Reads more like a tomatoes to apples comparison, because your arguments and figures are flawed.

gw wrote:Compare the income at age 65 from either the bond ladder or the annuity. Assume a constant 3.5% return on the bonds (equivalent to doubling in 20 years), invested from 30 years prior to age 65. Assume an SPIA pays out at 6.5% (borrowed this number from the thread, sounds about right). The rest is easy. The bond ladder is worth about $1M at age 65 (excel FV(.035,30,20)), and pays out $40K per year for 30 years. Buying a $1M SPIA pays out $65K per year for the remainder of your life.


The bond ladder is never worth “about $1m at age 65”.

First, the EE Bond buyer is, in essence, buying a series of deferred annuities for $20,000 on an annual basis. So, for 30 years, the investor has purchased 30 deferred annuities for a total of $600,000. Based on the amount invested in the EE Bond deferred annuities, the $40,000 annual payout figure would be 6.7%.

Secondly, even if you ignore that fact, the corpus of the bond ladder maxes out at around $820,000 (not 1mil as you stated). Remember, at age 65, only the first 11 EE Bonds that were purchased between the ages of 35 and 45 have reached the 20-year doubling mark (that’s $440,000). The remaining 19 EE Bonds in the ladder are only worth a bit more than the original $20,000, since the interest rate on those is a paltry 0.2% (that’s $380,00 plus a bit of interest). And at that point, withdrawals start depleting that balance from then on. Therefore, the figure of ~$1mil you used in to bolster your argument isn't accurate.

And you apparently overlooked the fact that the EE Bond ladder provides a 30-year period certain stream of income. So, again, the payout figure you used for the SPIA of 6.5% is also bogus since, contrary to your claim, you’re not comparing apples to apples. The actual payout rate for a 30-year term certain SPIA (without lifetime benefit) is actually ~4.56% from quotes I pulled from the internet.

So now we get to the real apples to apples comparison. Based on an $820,000:

The EE Bond annuity pays $40,000 per year or 4.9%
The 30-year period certain SPIA pays $37,392 or 4.56% based on a quote at one site I found.

The brkdirect link you linked to below shows a payout figure for a SPIA with lifetime benefits and a 30-year term certain to be 4.75% or $38,950 vs the $40,000 for the EE Bond ladder.

And if you want to add the inflation protection that you said was available, then the SPIA payments would be even less.

gw wrote:Obviously someone could choose the bond ladder over the annuity for valid reasons. However, if the goal is to have the benefits of an annuity (maximum safe income for the rest of your life, full stop), then a bond ladder is a terrible alternative, because (a) it risks running out of money and (b) it risks not running out of money, i.e., not being able to spend as much as you could with an SPIA.


I’ve shown that to be untrue when comparing apples with apples.

gw wrote:So I found the title of the article, and the article itself, very misleading.


And I found your post to be very misleading.

[edit: Apparently a 65-year-old male can get $71K today (http://www.brkdirect.com/spia/EZQUOTE.ASP), somewhat better than what I assumed above.


Finally, using the link you provided above, the actual payout for a 30-year term certain is 4.75%, not 7.1%.
From the link:

Your investment of $100,000 will yield 2.64% based upon our mortality assumptions and the U.S. Treasury yield curve as of March 5, 2013. This investment will provide you with $396 every month for the longer of 360 months or as long as you live, beginning on May 1, 2013.


Here are links to more information on where I got the quotes:
http://www.jdsannuities.com/immediate_annuities
http://www.comparativeannuityreports.com
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Re: Build Your Own Annuity

Postby Epsilon Delta » Tue Mar 05, 2013 11:38 pm

Mel Lindauer wrote:Finally, using the link you provided above, the actual payout for a 30-year term certain is 2.64%, not 7.1%.
From the link:

Your investment of $100,000 will yield 2.64% based upon our mortality assumptions and the U.S. Treasury yield curve as of March 5, 2013. This investment will provide you with $396 every month for the longer of 360 months or as long as you live, beginning on May 1, 2013.


$396 * 12 = $4,752 so the payout by your metric is 4.75%.

2.64% is the yield, which is a bit better than the 30 year yield on a EE bond.
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Re: Build Your Own Annuity

Postby Mel Lindauer » Wed Mar 06, 2013 12:30 am

Epsilon Delta wrote:
Mel Lindauer wrote:Finally, using the link you provided above, the actual payout for a 30-year term certain is 2.64%, not 7.1%.
From the link:

Your investment of $100,000 will yield 2.64% based upon our mortality assumptions and the U.S. Treasury yield curve as of March 5, 2013. This investment will provide you with $396 every month for the longer of 360 months or as long as you live, beginning on May 1, 2013.


$396 * 12 = $4,752 so the payout by your metric is 4.75%.

2.64% is the yield, which is a bit better than the 30 year yield on a EE bond.


Thanks for catching that. I'll fix it in my post.
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